Using volatile and correlated liqui

Using volatile and correlated liquidity shocks to investors as a source of noisetrading, I show that noise in stock prices impedes real efficiency. A one-standard-deviationincrease in mutual fund flow-driven volatility pressure leads to a 2.6%–4.0% decline inreturn on assets and a $22.6 million loss in cash flow in the subsequent two years. Noise instock prices does not affect product market demand, but it reduces firms’ total factorproductivity, profit margin, and performance in research and development and acquisitions.Further evidence suggests that noise in stock prices impedes real efficiencythrough three plausible channels: distorting firms’ investment decisions through misleadingprice signals, increasing the cost of capital, and reducing the efficacy of equitybasedincentive contracts.